Scenario: Two firms, Firm 1 and Firm 2, make differentiated products and compete in a duopoly market. The firms do not have a fixed cost. Firm 1's cost is $30 per unit, while Firm 2's cost is $25 per unit. (So they are the marginal cost and the average total cost). There are 1,000 consumers in this market. The demand is divided between the two firm in the following way:
• If Firm 1's price is less than twice Firm 2's price, then everyone buys from Firm 1.
• If Firm 1's price is more than twice Firm 2's price, then everyone buys from Firm 2.
• If Firm 1's price is equal to twice Firm 2's price, then half of the consumers buy from Firm 1 and the other half buy from Firm 2.
-Refer to the scenario above.Suppose Firm 1 sets the price at $50.If Firm 2 sets its price above $25,then its profit is ________.If Firm 2 sets its price below $25,then its profit is ________.If Firm 2 sets its price at $25,then its profit is ________.

Question

Quizplus · Accepted Answer

Given Firm 1's price is $50, if Firm 2 sets its price above $25, no one will buy from Firm 2 because Firm 1's price is not more than twice Firm 2's price, leading to $0 profit for Firm 2. If Firm 2 sets its price below $25, it will sell to all 1000 consumers but at a price lower than its cost of $25 per unit, resulting in a negative profit. If Firm 2 sets its price at $25, it matches its cost, leading to $0 profit because it neither gains nor loses per unit sold, and the demand is split due to Firm 1's price being exactly twice.

Scenario: Two Firms, Firm 1 and Firm 2, Make Differentiated